How to Get a Business Line of Credit: A Guide for Small Business Owners

Key Takeaways

➥ Businesses looking for a quick access to cash may find business lines of credit to be a convenient loan option. With one, they can address business expenses such as inventory replenishment, cash flow gaps, or any unforeseen costs.

 

➥ With a business line of credit, business owners can draw money when the need arises and only pay back what they used, plus the associated interest. Once they’ve paid it, their credit limit is restored to the original amount and they can draw money from it again if needed.

 

➥ You can apply for a line of credit in seven steps. Here’s how:

1. Evaluate your business’ credentials

2. Consider and understand your options

3. Know the lender’s requirements

4. Gather the documents

5. Understand the costs

6. Apply

7. Wait for approval

When small business owners find themselves in a cash crunch, they may explore small business loans for the additional cash injection their company needs. In doing so, they’ll likely discover that small businesses usually have a hard time qualifying for business financing from banks and traditional lenders.

While there are plenty of alternative business loan options available out there, business lines of credit tend to be more accessible than other types of financing. Once the lender opens a credit line, the borrower can immediately use the funds towards any business initiatives, such as inventory replenishment, equipment purchases, paying staff, ordering supplies or addressing temporary cash flow gaps and unforeseen business expenses.

If you’re looking for a cash flow boost for your business, you might be wondering how to get a business line of credit. In this article, we’ll give you a quick refresher on business lines of credit and guide you through the steps to get one.

What is a Business Line of Credit?

A business line of credit is a revolving credit that allows businesses to withdraw funds on an as-needed basis. The borrower then pays the borrowed amount back later (in increments), plus the interest rate

One of the biggest advantages of a business line of credit is that it gives business owners spending flexibility as the loan’s proceeds can be put towards virtually any business need.

How Does a Business Line of Credit Work?

Business lines of credit work a lot like a business credit card wherein the provider grants a set amount of financing that businesses can tap into anytime the need arises. They can then use the proceeds to meet their business’ day-to-day expenses or invest in big projects, as long as they don’t exceed the credit limit.

Once approved, businesses can get anywhere from $10,000 to $5 million in funding, depending on the lender, the business’ credentials, and the type of credit limit you’re applying for (secured or unsecured lines of credit).

Unlike conventional loans, you won’t have to pay the interest for the entire loan amount. With a business line of credit, you’ll only have to pay the interest on the money you’ve withdrawn. Once you pay off the money you’ve borrowed, the amount of credit available to you is restored. As long as you pay your balance on time, you can tap into the credit line again.

Example

Suppose the lenders approved you for a $10,000 business line of credit with an interest rate of 15%. You decide to take out $2,000. This leaves you with $8,000 of credit available on your credit line.

All that you are responsible for paying back is the $2,000 you used, plus the interest on it. In this case, that would be $300 ($2,000 x .15). Once you’ve paid the $2,300, your credit limit would be restored to $10,000.

How to Get a Business Line of Credit in 7 Steps

Like a typical small business loan, the application process for business lines of credit takes a few steps. If you’re planning to secure one for your company, here’s what you’ll need to do:

1. Evaluate your business credentials

Remember that applying for financing from lenders may entail a hard inquiry on your credit report. If you’ve applied for lines of credit from many different lenders and have gotten rejected, the many hard inquiries made on your credit report will leave a mark and negatively impact your business’ credit score.

That said, before applying for a line of credit from banks and other lending institutions, it’s always wise to evaluate your business’ credentials first to see if you can qualify. The better your credentials are, the higher your chances are of getting a business line of credit with excellent terms.

Here’s what the lenders will look at when evaluating your qualifications for a line of credit:

Revenue

Lenders only have one concern regarding borrowing: whether the borrower can repay the loan or not. Your annual revenue allows the lenders to evaluate your income’s progress (if it’s increasing from month to month or decreasing), and if it’s enough to meet the required repayments for the loan.

Consistent and stable growth in your revenue usually demonstrates that you have a good grip on running your business and that you’re executing your business plan appropriately. Not only will this improve your odds of getting a line of credit, it will also afford you better loan terms.

Credit Score

Among the first things that lenders look at when evaluating your eligibility for a line of credit is your personal and business credit report. Within that is your credit score, which is a testament to your repayment behaviors (whether you pay late or on time).

Ideally, your credit score should be in the “good” range, or 680+. However, other lenders may still be willing to work with borrowers with a bad or fair credit score. Additionally, you shouldn’t have any delinquent business loans or a history of default on your credit report, as this can affect your qualification, too.

The major credit bureaus use the FICO score in determining which category your credit score belongs to. Here’s a quick overview of each category:

Exceptional: 800-850

Very Good: 740-799

Good: 670-739

Fail: 580-669

Bad: 300-579

The higher your credit score is, the less risky you are as a borrower, and the better your chances will be in qualifying for financing with excellent terms.

Time in Business

Upon applying for a business line of credit, expect to answer questions about how long your business has been operating. Younger companies, considering that they haven’t established cash flow and credit history, tend to be riskier in the lender’s eyes since they don’t have much to go on when evaluating their capability to pay the loan.

In many cases, banks will look favorably upon businesses that have been around for at least two years. For younger companies, online lenders would be a better option as they’re more open to accepting businesses with a shorter history.

Collateral

If you’re applying for a larger loan amount, most lenders will require collateral. Collateral is an asset that you pledge as security for the financing. If you, the borrower, fail to meet the necessary repayments, the lenders can repossess the collateral, sell it and use the proceeds to pay for the loan balance.

The most common examples of collateral include real estate properties like buildings or houses. Assets like high-valued equipment, invoices, and inventory can also be used as security. Essentially, high valued collateral affords businesses with better loan terms and higher credit limits.

Note: Know that not all lending institutions will require collateral for their business line of credit. Online lenders are more likely to forego the collateral requirement and still grant the credit line. However, pledging collateral will afford you a line of credit with more favorable terms.

2. Consider and understand the options

Before moving forward with your application, it’s vital that you know what options are available. Do you need an unsecured line of credit, or do you prefer a secured line of credit? Will you need it long-term or short-term? Where should you apply for a business line of credit?

In short, there are a lot of considerations to think of before moving forward with your application. To make it easier for you, we’ve narrowed down the details below.

Secured vs. Unsecured Lines of Credit

First off, think about collateral. Secured business lines of credit require collateral to “secure” the loan. In other words, if the borrower defaults on the loan, the lender can seize the asset, liquidate it, and use it as payment for the loan. This ensures that the lenders will somehow get the payment back if the business can’t pay the loaned amount. Banks, specifically, don’t like risks and may only offer secured lines of credit to small business owners.

The upside is that secured lines of credit usually come with better loan terms like a lower interest rate, extended repayment period, and higher credit limits. If you have a lower credit score or revenue, backing up the loan with collateral will improve your odds of a business line of credit approval.

Unsecured business lines of credit, on the other hand, don’t require collateral to back the credit line up. In this case, the business lender shoulders a considerable risk since they would face a significant loss if the borrower defaults.

Online lenders and other FinTech companies may be more willing to take risks and offer unsecured lines of credit to small business owners. Their requirements are also less rigid than those of banks or credit unions. However, it’s worth noting that since they’re taking on a big risk in lending to small business owners without security, they’re likely to charge higher rates for the financing.

Long-term vs. Short-Term Lines of Credit

Next, consider whether you want a long-term or short-term credit line. This refers to the length of time you’ll have access to the credit line and the repayment period.

As the name implies, short-term business lines of credit have shorter repayment periods (about a year or less). The amount of time the business owner has to use the funds is also shorter (a year or less).

As for the loan purpose, short-term lines of credit are suitable if you’re looking to invest in business activities like implementing marketing strategies or buying additional equipment. Long-term lines of credit make more sense if you’re looking to invest in initiatives like business renovations, acquisitions, or opening another branch.

Banks vs. Credit Unions vs. Online Lenders

Banks, credit unions, and online lenders are the major sources of business lines of credit, and each has their own set of requirements to meet in order to qualify for one:

Banks

Among the three sources, banks usually offer the best financing terms – low-interest rates, extended repayment periods, and higher credit limits. If you qualify for a line of credit from a bank, you should probably take the offer. However, the affordability that banks offer also come with a particular downside: they’re the most difficult to qualify for.

To qualify for their business line of credit, companies will have to be operating for at least two years, have annual revenue of at least $250,000, and a credit score of 680 or higher. They also require more documentation, and their approval process takes longer than online lenders – with some applications being approved three months after application. If this works in your favor, business lines of credit offered by the banks might be the right choice for you.

Credit Unions

Credit unions are member-owned non-profit organizations. Like banks, credit unions also offer excellent terms for their lines of credit. To qualify, first and foremost, you have to be a member of the union or organization. To become a union member, you’ll have to meet another set of eligibility requirements and may be required to pay an annual membership fee.

One of the disadvantages of credit unions is that it might be harder to access the funds. Unlike banks, credit unions don’t have a lot of ATMs and branches. This could make drawing cash a hassle. Moreover, credit unions tend to have weaker mobile or online banking than bigger and more established banks.

Online Lenders

Among the three choices, online lenders are the least strict and most flexible lenders. They can work with businesses that have a poor credit standing, lower revenue, and even those still in the early stages of operation.

With online lending, you can complete your entire application process online. You’ll only have to attach a copy of your business financials, including profit and loss statements, balance sheets, identification, and other papers required by the lender, and upload it onto their database for review.

After that, the lenders will use a combination of manual and automatic underwriting to create an offer suitable to your current situation. Most online lenders won’t require collateral, so you won’t have to worry about putting any of your assets on the line.

Applying for a business line of credit from online lenders can take around one to seven days. If you’re in a hurry to get funding, online lenders are a viable option.

The only thing to note about online lenders is that the fast funding and easy qualification criteria come with a price. Online lenders tend to have higher interest rates compared to credit unions and banks.

The only thing to note about online lenders is that the fast funding and easy qualification criteria come with a price. Online lenders tend to have higher interest rates compared to credit unions and banks.

Additionally, if you have a poor business performance, revenue, or credit score, online lenders may see you as a high-risk borrower and may charge higher interest rates.

3. Know the Lender’s Requirements

Once you decide what type of lender you want to work with, the next step is to do your research and find out what that lender’s eligibility criteria is. In doing so, ask yourself these three questions:

What are their minimum credit score requirements? If you’re applying from a bank, they may require borrowers to have a credit score of 680 or better. Credit unions will require more or less the same credit score requirements. Online lenders may work with businesses with poor credit scores – with some granting lines of credit to companies with a credit rating of 500.

Do they have an annual revenue requirement? It’s worth noting that some banks and alternative lenders don’t require a minimum annual revenue, but you must be able to prove that your business is profitable. This could be through profit and loss statements, balance sheets, and others. However, banks that require a minimum annual revenue commonly set the baseline at $250,000 per year, while online lenders may ask for as low as $50,000 annually. Credit unions may require borrowers to bring in at least $100,000 yearly revenue.

How long should my business be operating as required by the lender? Online lenders are more willing to work with newer and younger companies. On the other hand, banks and credit unions may require businesses to be operating for two to three years.

Note that the line of credit requirements mentioned above are not definitive as lenders may set an independent qualification standard for their lines of credit. For instance, banks may or may not require borrowers to meet a minimum annual revenue. Or credit unions may accept borrowers with low credit standing as long as they’re a member of the organization.

To be sure, give the lender a call or visit one of their branches and ask what their minimum qualification requirements are.

4. Gather the needed documents

The documents you’ll need to submit will again vary from one lender to the next. If you’re applying from a bank or credit union, you’ll likely have to prepare a boat-load of documents to prove your creditworthiness. Online lenders, on the other hand, may only require the essentials.

In general, these are the requirements the lenders will most likely require if you apply for a business line of credit:

➥ Identification card

➥ Personal and business credit score

➥ Bank statements

➥ Tax returns

➥ Balance sheets

➥ Annual revenue

➥ Profit and loss (P&L) statements

➥ Debt schedule

➥ Legal contracts (franchise agreements, articles of incorporation, business lease, etc.)

Tip: Preparing the needed documents beforehand and submitting the complete set of requirements will help expedite the loan process. Some lenders may ask for more documents (i.e., certifications, resumes, etc.) after the initial evaluation to further determine your qualification, so be sure to know what those are. This way, you can prepare and submit them immediately in case the lender asks for them.

5. Understand the costs

When applying for a small business loan like a business line of credit, you have to understand that there are fees that you’ll need to pay upfront or throughout the duration of your loan. Specifically, the lenders may charge an annual percentage rate (APR) or a simple interest rate.

Annual percentage rate (APR) vs. Simple Interest Rate

The annual percentage rate (APR)is the yearly cost of the loan charged to borrowers. It’s equivalent to a certain percentage of the loan amount, which the borrowers have to pay annually. The APR already includes all the fees attached to your account, which may consist of origination fee, guarantee fee, application fee, service fee, and more. This is usually fixed and is best for long-term business lines of credit.

A simple interest rate is a percentage the lenders charge on top of the loaned amount. This doesn’t include the other fees you’ll have to pay for the loan. Simple interest rates make more sense if you’re loan’s repayment period is less than a year.

Prepayment Fees

While paying off your loan earlier is a good thing, lenders don’t exactly see it that way. That is because they won’t be able to gain much from the interest rates if you decide to finish off the payments earlier than the expected date.

That said, many lenders will include a prepayment penalty fee within the loan contract. The primary purpose for this is to disincentivize the borrowers from paying the loan off early.

If you’re applying for a business line of credit, be sure to review the business loan agreement thoroughly. Most importantly, look at the fees section to understand what you will be paying for if you decide to proceed with the application.

It’s worth noting not all lenders charge a prepayment penalty, so if you do decide to pay off your loan earlier, you can freely do so without worrying about the fees.

Other Fees

Lenders may also charge other fees aside from the prepayment penalty fees, and it’s essential to familiarize yourself with these.

Draw fees. These are the fees that you pay each time you draw money from your credit line

Late fees. If you miss a payment deadline, the lenders will charge a late fee as a penalty

Termination fees. Suppose you decide to close your credit line before the designated time. In that case, the lenders will charge a termination fee to discourage you from doing it. This also guarantees that they will somehow recoup the losses if you decide to terminate your account early.

6. Apply

By this point, you’ve picked a lender and have the required documents prepared. Now it’s time to physically submit your application.

If you’re applying with a bank or credit union, contact the lender and visit one of their branches personally. Submit all the required application forms along with the documents needed for the application. The bank may conduct a short interview asking you about your experience, challenges, and how you’ll use the funds. Be as transparent and honest as you can be. If they find out you’re lying, this will only hurt your chances of approval.

If you’re applying from online lenders, head to their website and follow their step-by-step application process. You’ll only have to fill out some fields and attach the files containing your financial information along with the other requirements. This will probably take 10 to 15 minutes tops.

7. Wait for approval

Once you’ve submitted your application, the only thing left to do is to wait.

For bank applications, expect to hear back from the lender within a few days or weeks. As mentioned, banks are known for their time-consuming application process. Approval could take anywhere from several weeks to a few months.

Business lines of credit from online lenders, on the other hand, are much faster. Once you send your application in, along with the documents, they will send a notification indicating that they have received your application. Since they’re using smart algorithms to help them evaluate your eligibility for the credit line, you can expect to hear back from them within a day.

Why Consider Applying for a Business Line of Credit?

Like a typical small business loan, the application process for business lines of credit takes a few steps. If you’re planning to secure one for your company, here’s what you’ll need to do:

Why You Should Still Consider Equipment Loans Despite the Credit Check

Aside from the flexibility, business owners typically go with a business line of credit because it allows them easy access to funding if and when they need it. Once the lenders approve your business line of credit application, you can start using the funds right away. If you need more, you won’t have to apply again, as you can just draw from the credit line that was recently granted to you.

Business lines of credit also provide a significant amount of funding to small business owners. In general, lenders can fund anywhere from $10,000 to $5 million, depending on the business’s credit background and financial performance. This amount can be helpful for companies looking to solve cash flow gaps or those looking to invest in large business projects like business acquisitions, equipment purchases, or product expansion.

Start-ups looking for a boost in their capital may also find business lines of credit an excellent funding option for their small business. Though it may be difficult for them to qualify through banks, business lines of credit offered by online lenders can be a more practical alternative.

Moreover, compared to term loans or merchant cash advances (MCAs), lines of credit are typically more affordable. As mentioned, you’ll only have to pay interest on the amount you draw from your credit line. Plus, if you have a stellar credit background, the lenders may be able to offer lower the interest rates for your loan.

The Bottom Line

A business line of credit is one of the most valuable funding resources you can have for your business. With one, you can have access to funds if and when you need it. Plus, once you have the cash, you can use it for any business purpose – be it for additional working capital, equipment repair or purchase, inventory reordering, or as a cushion during emergencies.

Getting a business line of credit doesn’t necessarily have to be a chore. It all comes down to evaluating your qualification for the loan, finding the right lender, and submitting the required documents, including the application form. If you do it right, you might just get the lender’s sweet approval and start growing and expanding your small business.